Foreign Lenders in Emerging Economies

Raoul Minetti and Matteo Iacoviello

No 1050, 2010 Meeting Papers from Society for Economic Dynamics

Abstract: In recent decades, after liberalizing their credit markets emerging economies have frequently experienced sustained output growth but also large volatility of output and asset (e.g., real estate) prices. This paper studies an economy where firms face credit constraints tied to the pledgeable returns - output and collateralizable assets - of their investments and domestic and foreign lenders have different comparative advantages in obtaining investment returns. Building on evidence from emerging economies, we postulate that foreign lenders are more efficient than domestic ones in monitoring the output of specialized assets but have less information in the local market where assets are traded. The analysis reveals that opening the economy to foreign lenders can raise average productivity and output but also the volatility of output and of the price of collateral assets over the business cycle. These effects appear more pronounced the lower is the degree of contract enforceability in the economy.

Date: 2010
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